Opinion

Felix Salmon

When default rates spike

By Felix Salmon
April 15, 2009

Many thanks to Jeffrey Benner of Moody’s, who responded to my blog entry yesterday with some very useful information about downgrades and default rates.

Firstly, the 13.8% downgrade rate in the first quarter means that Moody’s downgraded 13.8% of all its corporates in the first quarter alone: it’s not an annualized rate, and Moody’s therefore downgraded a higher percentage of the companies it covers in the first quarter of 2009 than it does in a typical year.

As for absolute ratings quality, I haven’t managed to get good data on that. But Moody’s does have good data on default rates, and has even provided a couple of charts: the first shows how the spike in annual default rates is expected to surpass the 1991 and 2002 peaks, while the second puts those peaks into perspective going back to 1920.

defaultrates2.tiff

default rates.tiff

The second graph is particularly interesting to me, since it really puts the Great Moderation in perspective. A couple of years from 2004 through 2007 doesn’t make a Great Moderation; for that you really want to look at the period from say 1943 to 1970. One of the consequences of the rise in the pace of financial innovation of late is that the global financial-services industry could take a really very short-lived decline in default rates and credit-market volatility, and turn it into something so dangerous as to create the worst global recession in living memory. Once upon a time, you could go for decades without seeing the default rate rise over 3%. Nowadays, the chase for return on equity won’t ever let that happen.

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